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Green Mountain: After the Drubbing

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Last week was a brutal eye-opener -- of Un Chien Andalou proportions -- for bulls of Green Mountain Coffee Roasters (Nasdaq: GMCR  ) . I should know. I was one of them.

After scaling a wall of worry with every passing quarter, Green Mountain finally proved mortal. The growing chorus of bears arguing that the Keurig business is slowing finally got it right. The stock shed nearly half of its value, as Green Mountain missed its own sales projections and hosed down top- and bottom-line forecasts for the entire fiscal year.

What the bulls are missing
There are some bullish responses that need to be discarded here.

  • "Well, at least Green Mountain grew revenue and earnings by 37% and 33%, respectively. That's not too shabby." That may be true, but remember that Green Mountain was targeting net sales to climb as much as 50% higher several weeks into the period. Business deteriorated in the final two months of the quarter, and that's what's important as we eye the company's near-term prospects.
  • "Green Mountain is still looking to grow net sales by 45% to 50% this year. That's not too shabby." Again, this is a figure that leans too heavily on the company's success in the past. Net sales more than doubled during the company's first fiscal quarter.

In order to assess where Green Mountain is at the moment, it's a good exercise to slice out the first half of the fiscal year. What does the company's outlook for all of fiscal 2012 -- calling for a profit per share of $2.40 to $2.50 on a 45% to 50% top-line bump -- really mean?

Well, if we remove what the company has already earned and generated in net sales during the first half of fiscal 2012 and compare the balance of the guidance with what the company cranked out during the latter half of fiscal 2011, we get a much clearer picture. Green Mountain's new guidance is telling investors to expect earnings growth of 21% to 31% during the final six months of the fiscal year along with a 23% to 37% increase in net sales.

The instinctive reaction may be that Green Mountain is a bargain even with the sobering near-term projections. Green Mountain at 10 times this fiscal year's lowered earnings guidance is a deep discount to its growth. Unfortunately, we saw how flawed the company's guidance was three months ago. If business is truly deteriorating, more downward revisions will follow.

What the bears are missing
The naysayers have every right to gloat. The bears won last week. Inventory levels are still troublesome, and demand is slipping even before the company tackles K-Cup patent expirations later this year. Analysts may be marking down their profit estimate for fiscal 2012 to match the company's new guidance, but they're giving fiscal 2013 an even bigger haircut. Calls for a profit of $3.68 a share in the new fiscal year that begins in October have been whittled down to $3.15 a share.

The bears clearly have broader bragging rights, but there are also a couple of arguments that they can't fairly make at this point.

  • "There's been too much insider selling and secondary offerings here. Investors should've run at the first sign of a secondary." Equity historians will naturally make it a sport to single out the reasons for souring of this growth stock since peaking last summer, but don't blame the secondary offerings. These admittedly dilutive moves helped bankroll the purchase of several leading coffee makers, setting up the company for growth even after the upcoming K-Cup patent expirations. More to the math, the stock closed at a split-adjusted $22.49 the day the first secondary was announced in the summer of 2009. Obviously holding since then hasn't been much of a winning investment, but anyone that saw that as a shorting signal would be at a loss even after last week's plunge.
  • "Green Mountain is still overvalued." Really? Let's compare Green Mountain to market daring Starbucks (Nasdaq: SBUX  ) . Analysts see Starbucks growing its profitability by 25% in fiscal 2013. Wall Street's new haircut on Green Mountain estimates still have the company growing its net income by 29% in the same fiscal 2013. Green Mountain is fetching less than eight times next year's target. Starbucks is trading at a 24 times next year's earnings. Is the slower-growing Starbucks really worth three times the multiple?

Bears will respond "of course" to that final question. There are plenty of question marks when it comes to Green Mountain. We may be two years removed from an accounting restatement, but fears that Green Mountain stuffed its distribution channels last year -- and are paying the price now -- have yet to be silenced. Inventory control concerns remain, though at least one of last year's bearish knocks has been diminishing. Operating cash flow has more than tripled through the first six months of this fiscal year.

Cynics have grown concerned about discounting in the coffee industry in recent months. They see McDonald's (NYSE: MCD  ) selling small coffees on the dollar menu, and wonder if closing the pricing gap with one-cup brewers will sting. They saw closeout retailer Big Lots (NYSE: BIG  ) selling select K-Cups brands at markdowns earlier this year. Arabica beans -- after rallying last year -- recently hit a 52-week low, so java in general will get cheaper. Lost in last week's report is that Green Mountain did sell 47% more K-Cups than it did a year earlier at an average price that is 12% higher.

The concerns are real. There are questions still left unanswered. David Einhorn nailed it with his bearish call last year. However, the popularity of Keurig continues to move in the right direction, even if it's no longer moving at the same speed.

September's patent expirations will leave a mark, but the resulting drop in K-Cup prices will only make the platform more popular and nudge Green Mountain toward cashing in on its Keurig patents and licenses as profit centers as its many coffee brands jockey for position.

It may take time for Green Mountain to gain the market's respect, but the valuation -- and Green Mountain's new appeal as a buyout at these levels -- makes this a dangerous time for the shorts to continue high-fiving one another.

Brew ha ha
Shares of Green Mountain have still handily beat the market since I originally recommended the java heavy to Rule Breakers subscribers three years ago. It's lost a lot of ground -- and grounds -- lately, but if you want to discover the newsletter service's next rule-breaking multibagger, a free report tells all. Check it out before it's gone.  

The Motley Fool owns shares of Starbucks. Motley Fool newsletter services have recommended buying shares of Green Mountain Coffee Roasters, McDonald's, and Starbucks. Motley Fool newsletter services have recommended writing covered calls on Starbucks. Motley Fool newsletter services have recommended creating a lurking gator position in Green Mountain Coffee Roasters. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Longtime Fool contributor Rick Munarriz calls them as he sees them. He does not own shares in any of the stocks in this story, except for Green Mountain. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

Read/Post Comments (2) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 07, 2012, at 10:27 AM, reggidmalc wrote:

    Rick, good review of the bull & bear on GMCR. I bailed out on it 2 yrs ago when it began to get too frothy for me. Like all momo stocks it shot too high and now is probably too low. The only real issue I see now is management quality. They have done a great job growing and dominating the single serve market in the US, but can they operate (i.e. cash flow, inventories, competitors, etc.) effectively? I doubt if there is fraud involved but it would be nice to put that to rest, too. Maybe time to buy a few shares again?

  • Report this Comment On May 07, 2012, at 8:38 PM, CharlieTav wrote:

    Shorts have a short memory. Last fall GMCR missed and stock dropped from $70 to $39. The following QTR (4th Calendar QTR) Revenue smashed analyst expectations and the stock soared back to $67 to $70. Revenue that was missed in the 3rd Calendar QTR was picked up in the 4th Calendar QTR and then some.

    K-cups have not peaked. Revenue that was missed last QTR could be picked up this QTR for the following reasons

    1- announcement of Vue-pac - consumers and retailers were waiting for the new machine and running inventory low on K-cups, not knowing impact of Vue pac machine. Announcement was made in March prior to ending of QTR.

    2- Retailers cutting back inventory after holiday - will have to replenish this QTR.

    3- Starbucks recent announcement to increase K-cup purchases via two new types of blend

    4- Starbucks will sell Vue packs 4th Calendar QTR. Consumers will start purchasing Vue Machines 2nd and 3rd Calendar QTR. GMCR stated no material impact this fiscal year (Sept 12) . They are setting themselves up to beat expectations with Vue Machines, Gravy to the Top Line

    It is absurd to say K-cups have peaked. The growth is just starting.

    Worst case scenario Nestle's, or another company will look at GMCR as an attractive buy out.

    What about McDonalds - they have entered the coffee boutique market. ?

    What about Starbuck K-cups in China ?

    Vue pac will deliver a higher quality brew method

    I was told 198 F brew temp exacts the optimum flavor of coffee beans.

    Analyst will be making a mistake by discounting the Vue Machine and sale of Vue pacs

    The Management missed 2 QTRS in the last 3 years that I have been following. I think that is very good record and have gone out of their way to be conservative.

    The possibilities are endless. The K-cup way to drink coffee will be the dominant way. Hotels / Restaurants / Consumer / Airlines

    Long GMCR - one must have courage of their convictions

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